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The EU CO 2 Emissions Trading Scheme

Denny Ellerman Center for Energy and Environmental Policy Research Massachusetts Institute of Technology New Directions in Regulation Seminar JFK School, Harvard University October 22, 2007. Massachusetts Institute of Technology Center for Energy and Environmental Policy Research.

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The EU CO 2 Emissions Trading Scheme

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  1. Denny Ellerman Center for Energy and Environmental Policy Research Massachusetts Institute of Technology New Directions in Regulation Seminar JFK School, Harvard University October 22, 2007 Massachusetts Institute of Technology Center for Energy and Environmental Policy Research The EU CO2 Emissions Trading Scheme

  2. Market Development 2005-06 Results: Over-allocation? Allocation choices Broader Implications Topics

  3. 27-state multinational CO2 trading system Classic cap-and-trade covering large sources About 45% of EU CO2 emissions Hybrid implementation of Kyoto Protocol Trading and non-trading sectors Decentralized cap within a cap with CDM linkage 2005-07 trial period, 2008-12 second period, and post 2012 periods The EU ETS

  4. Mostly futures trading in front contract Also, spot but 10-15% of total volume OTC market initially, but exchanges developed quickly and account for 30-40% of volume US allowance markets all OTC An EUA is a downloaded AAU, but non-EU AAUs are not acceptable; CERs/ERUs are. Also any linked systems: probably Norway The EUA Market

  5. EUA PricesJan 2005 - Present

  6. Higher than expected initial prices Energy price relations Adverse weather Institutional features Sharp adjustment upon revelation of lower than expected emissions All prior information was speculative Similar response in US SO2 program End-of-period price separation Three Prominent Features

  7. Unrestricted intra-period banking and borrowing, but none between trial and subsequent periods Explains 1st and 2nd period price separation in 2007 Inter-period banking expected from 2008-12 on Temporal Trading: An Important Pricing Feature

  8. Temporal Restriction Does Affect Prices

  9. Kyoto Parties in Deficit (Japan, Canada, NZ) Non-Annex I Kyoto Parties (China, India, Brazil, etc.) CERs Subject to supplementarity limits Kyoto Parties with Surplus AAUs (Russia, E Europe) Non-ETS Sectors ETS Sectors (Gov’t responsibility) (Private Responsibility) (AAUs remain as such) (AAUs converted to EUAs) EU Kyoto AAUs Linked to a Complicated International Market

  10. Market Development 2005-06 Results: Over-allocation? Allocation choices Broader Implications Topics

  11. Not an issue until first data release Muddled concept; conflated with being long With inter-period banking constraint, sure to be either long or short Concept also used to imply no abatement; data are showing abatement Inherently difficult problem of ensuring shortage with ambition is modest; ex post rarely coincides with ex ante EU ETS: Over-allocation

  12. Market Development 2005-06 Results: Over-allocation? Allocation choices Broader Implications Topics

  13. Delegation to member states to decide total and distribution with  95% grandfathered Member state decisions subject to review by the European Commission In practice, limited to the proposed totals, and No ex post adjustment or quota management Huge data problems at installation level Extended discussion between industry and government on data and allocation principles Allocation in the EU ETS

  14. Allocations based on recent emissions Benchmarking proved infeasible Shortage allocated to the power sector More abatement possibilities & no competitive problems Very little auctioning (4 MSs & 0.13% of total) New entrant and closure provisions Potentially distorting effects but ubiquitous What Choices were Made?

  15. Near universal disapproval of grandfathering, yet always chosen Is there more than just politics & lobbying? Unacknowledged social norms? Lockean prior use and squatter rights EU variant: production conveys the right A convergence of fairness and expediency? Allowances permit Coasian separation of efficiency and equity Assign rights to mitigate financial impact of the change in prices and rules Principles or Politics?

  16. More auctioning: 11 MS’s,  3% of total Some increase in benchmarking, but still little Substantially lower caps Based on aggregate 2005 Verified emissions All East European MS’ suing in ECJ Wide variation among MSs (-19% in Denmark to +33% in Lithuania (relative to 2005 emissions) Updating at micro level only in East Europe NAP2 Differences

  17. Evolution of Auctioning in the EU ETS

  18. NAP2 (2008-12) vs. NAP1 (2005-07)

  19. Market Development 2005-06 Results: Over-allocation? Allocation choices Broader Implications Topics

  20. The East European challenge in NAP2 Expanding the scope: Aviation proposed The ETS (post-2012) Review: Dec 07 An EU-set cap? -20% from 1990 Much higher auctioning share? More harmonized allocations? Maintaining a credible price Overlapping mandates (i.e., renewables) International market linkage (CERs, greened AAUs) The Next Steps for the ETS

  21. A multinational trading system with a uniform price on carbon throughout the EU The east/west parallel to the global north/south divide Differing criteria for EU15 and Accession-10 Differing responsibilities for non-covered emissions What made all 25 join up? The European idea? Or the benefits of the club? The EU ETS as Prototype

  22. The Fact on the Ground The Pioneering Example Learning experience for those who follow The subtle influence on the American debate The €20/tonne incentive and the CDM Attracting interest from those outside Influencing Chinese and Indian preferences The Geopolitical Importance of the EU ETS

  23. Continuing the EU ETS and keeping it open Avoiding trans-Atlantic acrimony in global environmental diplomacy First step is linking EU and US systems Developing combination of community and interest that will attract others (as in the EU) Finding a multinational institution to coor-dinate and negotiate accession/membership The Challenges Ahead

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